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Two Democratic senators have agreed to co-sponsor a bill that would allow Puerto Rico's municipalities to use federal bankruptcy laws, the U.S. territory's representative in Congress, Pedro Pierluisi, said and Reuters reported yesterday. Senate judiciary committee chairman Patrick Leahy and Mark Warner, who sits on the Senate's banking and finance committees, will join 12 other Democratic senators currently sponsoring the bill. The bill (S. 1774) was introduced last week to give Puerto Rico's municipalities and public corporations access to chapter 9 of the Bankruptcy Code to adjust their debts. It is a companion bill to an identical bill (H.R. 870) that Pierluisi introduced in the House earlier this year.

As a Puerto Rico agency veers toward a default as soon as Aug. 1, federal officials have echoed a refrain heard during recent state and local fiscal crises: Fix the problem on your own, Bloomberg reported today. President Barack Obama’s administration and the Federal Reserve have said it’s up to Congress to decide how to assist the island as it struggles with $72 billion of debt. Yet on Capitol Hill, Puerto Rico’s push to allow some agencies to file for bankruptcy has stalled. Efforts to find a Republican to co-sponsor the legislation haven’t borne fruit. Puerto Rico has been moving toward the largest restructuring ever in the $3.6 trillion municipal-bond market since last month, when Gov. Alejandro Garcia Padilla said that the commonwealth can’t afford to pay its debts. The securities have tumbled amid speculation over how much investors stand to lose as his administration moves to draw up a restructuring proposal by Sept. 1.

On July 21, 2010, President Barack Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act, aimed at ensuring the financial system would never again bring the U.S. to the brink of economic disaster, but five years later, the job remains far from done, according to an opinion posted today on Bloomberg. To some extent, regulators have used their powers under Dodd-Frank to require more capital. As of Dec. 31, the six largest U.S. banks had, on average, about $5 in equity for every $100 in assets (calculated according to international accounting standards). All else equal, that's enough to absorb a 5 percent loss on assets, up from less than 4 percent in June 2012. If big U.S. banks' finances are so precarious, how can they function? The answer is that creditors expect the government to step in and rescue the institutions if they get into trouble. This "too-big-to-fail" status allows the banks to borrow more cheaply than their inadequate capital cushions would otherwise allow — an implicit subsidy that benefits their executives and shareholders. Judging from recent research by economists at the New York Federal Reserve, the subsidy has so far survived Dodd-Frank's efforts to eradicate it. The law's anniversary will undoubtedly elicit calls to roll back financial regulation. In some cases, changes would make sense. In core areas such as bank capital, however, regulators still have a long way to go. If equity requirements were raised enough to eliminate implicit subsidies to the biggest banks, shareholders would have a greater incentive to break them up into more manageable — and more valuable — businesses. Perhaps then, regulation could be made simpler, too.

Federal Reserve Chair Janet Yellen said she would be open to a “modest increase” in the asset level for subjecting banks to tighter oversight, calling the $50 billion threshold an unnecessary burden on smaller lenders, Bloomberg News reported today. Responding to questions at a Senate Banking Committee hearing yesterday, Yellen acknowledged that banks just above the level set by the Dodd-Frank Act are already facing costly demands such as requirements to undergo stress tests and write plans for how they could go through bankruptcy in a failure. “For some of those institutions, it does look from our experience, that the costs exceed the benefits,” Yellen told lawmakers. If the bar were raised, she said, the Fed should retain power to designate smaller banks based on risk. Senator Richard Shelby (R-Ala.), who leads the Banking Committee, has introduced legislation that would raise the bar for systemic designation to as high as $500 billion in assets. Democrats including Sen. Sherrod Brown of Ohio and Elizabeth Warren of Massachusetts have led opposition to the Shelby bill, saying that it would exempt banks that could threaten the financial system and lead to taxpayer bailouts.

Lawmakers are weighing tweaks to the Bankruptcy Code to prepare the federal court system for the next big bank failure by allowing a quick sale without the financial-market freeze that occurred when Lehman Brothers Holdings Inc. filed for chapter 11 in 2008, the Wall Street Journal reported today. Several bankruptcy lawyers testified yesterday before a U.S. House subcommittee on regulatory reform about the recently reintroduced Financial Institution Bankruptcy Act, which would give bankruptcy judges the power to privately transfer a struggling bank’s assets to a new, more stable owner in less than 48 hours. For several lawmakers, there was a lingering concern about who will pay for the bank-transfer process. The wind-down of Lehman Brothers, for example, has cost more than $2 billion in fees to professionals. Experts on big bank failures have said that the U.S. government might be the only body willing to lend to a struggling bank, leading to the problem of bailouts. Bankruptcy lawyer Richard Levin of Jenner & Block LLP said that he supports the availability of government money to provide liquidity to the transferred bank assets, saying that financial markets are likely to run more smoothly knowing that such a funding mechanism exists. Levin testified alongside fellow restructuring lawyers Donald Bernstein of Davis, Polk & Wardwell and Stephen Hessler of Kirkland & Ellis. All three agreed that the bill could have helped saved Lehman Brothers from collapse, in addition to the other measures that passed after the financial crisis. Read more. (Subscription required.) 

Click here to watch a replay of the hearing and to read the prepared witness testimony. 

A chapter 9 solution to Puerto Rico’s economic and financial woes, as the House Judiciary Committee is contemplating via H.R. 870, is ill-conceived on several grounds, according to a commentary in today’s Roll Call. First and foremost, the bill’s passage would override with retroactive effect the bond indentures of the millions of investors throughout the U.S. who have bought Puerto Rico’s bonds, mostly through mutual funds. H.R. 870 would give carte blanche to the Commonwealth to break its solemn pledge that our bonds would be paid in accordance with the laws and contracts under which they were issued, according to the commentary. Second, H.R. 870 would authorize only the island’s public utilities and agencies to restructure their debts under the supervision of a federal bankruptcy judge. Depending on how broadly it would be implemented, a chapter 9 process would thus apply merely to between one-fifth and one-third of the Commonwealth’s more than $70 billion of debts to bondholders and banks, according to the commentary. The bulk of public indebtedness would have to continue to be serviced in full and on a timely basis.

Puerto Rico’s $72 billion debt saga has become a booming business for Washington, D.C., lobbyists, who are developing websites, creating advertisements and lining up the support of conservative advocacy groups, Bloomberg News reported today. The junk-rated island’s woes have been a topic of debate on Capitol Hill since February, when Pedro Pierluisi, the island’s resident commissioner in the U.S. House of Representatives, introduced H.R. 870. to amend the Bankruptcy Code to treat Puerto Rico as a state. The bill would give Puerto Rico the option to authorize its municipalities and public agencies to file for chapter 9 protection. Chapter 9 currently doesn’t apply in Puerto Rico, a territory since the Spanish-American War.